Broadgate: Weekly Briefing 21/10

21 October 2013

U.S. – The U.S. Congress has passed a bill to reopen the government and raise the federal debt limit, with just hours to spare before the nation risked default.

It came hours before the deadline to raise the $16.7tn limit was expected to expire, pulling the U.S. back from the brink of economic disaster. The bill extended the treasury’s borrowing authority until 7 February.

It also funds the government to 15 January, reopening closed federal agencies and bringing hundreds of thousands of employees back to work.

However, the situation is far from resolved, although markets across the U.S. closed higher, the Democrats and Republicans are still divided over the budget and it will have to be renegotiated early next year.

Japan – Japanese shares rose, with the Topix index climbing to a three-week high on Thursday, after the U.S. Congress voted to end the government shutdown and raise the debt ceiling, ending the nation’s fiscal impasse.

Companies such as Nissan Motors, an automaker that gets 34% of sales in North America, surged following the announcement.

The Topix gained 0.8% to 1,206.25 at the close in Tokyo, its highest since Sept. 27. All but three of the 33 subsectors climbed.

India – India’s inflation rate rose to a seven-month high in September, limiting the room for authorities to ease monetary policy as they look to spur growth. The Wholesale Price Index, India’s main gauge of inflation, rose 6.46% from a year earlier, up from 6.1% in August.

Rising consumer prices have been a concern for policymakers, preventing them from taking aggressive measures to boost India’s slowing economy. The data comes after India, Asia’s third-largest economy, has seen its growth rate decline.

Its economy grew at an annual rate of 5% in the 2012-13 financial year, the slowest pace in 10 years.

There are concerns that its growth rate may dip further, amid a slowdown in the manufacturing sector and declining foreign investment in the country, that has triggered calls for the central bank to ease some of its policies, in an effort to spur a fresh wave of economic growth.

Trends – Fund investors cut exposure to U.S. equities and looked to alternative options last week as Washington’s deadlock over the U.S. federal budget continued.

The negative flows came after the U.S. government spent a second week in partial shutdown as the Democrats and Republicans failed to reach a compromise on the country’s budget.

EPFR Global says: “Fears that intransigent American lawmakers would misjudge the consequences of their reluctance to compromise on the federal budget and national debt ceiling saw investors – especially retail ones – shying away from U.S. fund groups during the first full week of October.

“Investors looking for less uncertain economic policy environments turned to Europe, Japan and, to a lesser extent, China during the week.” European equity funds witnessed a 15th consecutive week of capturing new money, marking their longest inflow streak since the 16-week-long run that ended in May 2002.

Japanese equity funds took more than $1bn for the third time in five weeks, while Chinese equities saw their first back-to-back week of inflows since mid-February.

Commodities – Gold will drop in each of the next four quarters and reach a four-year low as reduced U.S. stimulus in response to faster economic growth curbs demand for bullion as a haven, the most accurate forecasters have predicted.

The metal will decline to an average of $1,175 an ounce in the third quarter next year, or 10% less than now, according to the median of estimates from the 10 most-accurate precious metals analysts tracked by Bloomberg over the past two years. Prices were last at that level in 2010.

“Desire to buy gold as a hedge against the consequences of monetary policy has diminished,” said Tom Kendall, an analyst at Credit Suisse, whose precious-metals forecasts were the second most-accurate over the past two years.“When you’ve got other asset classes, equities in particular, doing so well, then it’s hard to divert investments out of them and into something like gold, which is falling.”

Spotlight on: Major investment themes for the future

HSBC Private Bank’s Nigel Webber and Esty Dwek identify the major investment themes that will shape asset class returns in the coming decades, and which regions are likely to be affected by them.

Investors often tend to focus on the short-term and, with so many twists and turns in the road to recovery since the financial crisis, who can blame them? But in our view it is also important to take a step back and look at the bigger picture.

Indeed, we believe that a number of mega trends are developing, which will have a significant impact on economics and asset class returns over the very long-term.

Demographics

Although the global population is increasing, many countries – especially in the developed world – are facing two serious problems: firstly, population shrinkage and reduced workforce; and secondly, an ageing population.

These are problems because economic growth needs population growth and particularly working-age population growth as well as productivity growth. In addition, older populations mean lower tax intakes and higher social costs, which can exacerbate already precarious government debt situations in Japan and Europe, and are a cause for concern in China and Russia.

The annual population growth rate in many major economies is expected to fall in the coming decades, with the growth rate already negative in Japan, and the European Union and even China falling below zero – implying that by 2025, the population will be shrinking. The UK growth rate is expected to remain barely in positive territory, while the U.S. will continue to grow, keeping up with India and Brazil.

Working age population forecasts paint a similar picture. Already, expectations are falling for the working population by 2020 and 2050 in Europe, Japan and China. Indeed, it seems that the working population in China peaked in 2011, and has already started to decline.

The UK is expected to remain nearly flat, while the U.S. is likely to see a big boost to its working age population, in part thanks to its immigration laws, which should allow younger generations of foreigners to join the U.S. workforce in the coming years.

In light of these developments, we expect U.S. economic growth to remain supported by these trends, while risks to growth for Japan, Europe and China are increasing. The rest of the emerging markets should fare better in the next 10 to 20 years, especially Africa, the Middle East and India, where population growth is expected to be strong.

Energy revolution

The discovery of shale oil and gas reserves in many regions has far-reaching implications for the global economy and for politics, as the cost of energy remains a significant part of many companies’ and households’ budgets. Countries with access to cheaper energy in the coming decades are likely to have a significant economic advantage.

Interestingly, the shale reserves are generally not in the same countries where oil and gas are found today. This implies some positive developments for countries that will suddenly have access to cheaper energy sources and negative consequences for countries that may no longer be able to depend on their oil exports to fund their budgets.

Northern Europe, northern Africa, Pakistan, China, South Africa, Australia and many Latin American countries have shale reserves, while the Middle East, India and the rest of Africa less so. The top-six countries with technically recoverable shale oil resources are Russia, the U.S., China, Argentina, Libya and Australia. The top-six countries with technically recoverable shale gas resources are China, Argentina, Algeria, the U.S., Canada and Mexico.

When these discoveries are accessed, it should lead to lower energy prices, as it has done in the US. This should be supportive of the global economy. The U.S. is at the forefront of developing and investing in extraction techniques. This will have a significant impact on U.S. energy imports, which should sharply reduce the US trade deficit over time and support the US dollar.

Others with such reserves – China, the U.K., Argentina – are moving towards developing these techniques, but they may still be at least 10 years away. Energy independence for the U.S. and others is a key risk for the Middle East, where most countries fund their budgets through oil exports.

Economic experimentation

Massive quantitative easing (QE) by the largest central banks is bound to have long-term implications, but those are as yet unknown.

Since 2008, the four major central banks have more than doubled their combined balance sheets, and most remain on the path of expansion. Indeed, even when the Federal Reserve (Fed) does start to taper its asset-purchase programme, it is only a reduction in stimulus, not a tightening in liquidity conditions.

The U.S. and Japanese economies, and even the UK, have benefited from QE and have seen their economies recover. But questions remain: what happens when central banks normalise policies and the flood of liquidity ends? And will central banks be able to manage this withdrawal in an orderly manner?.

Today, with expectations for reduced Fed support, we are seeing increased market volatility with a natural impact on fixed income, while equities have managed relatively well. But will this continue?.

And further out, the main risk may be inflation as the abundant liquidity could lead to asset bubbles.

Impact of the mega trends

In our view, the U.S. is likely to be the main beneficiary of these very long-term trends. The country’s growth prospects should be supported by positive demographic trends and the shale energy revolution. This should also translate into attractive stock market opportunities over the long-term and U.S. dollar strength.

The emerging markets’ outlook is generally supported by energy improvements in countries including China, and positive demographic trends in countries excluding China. We should see positive trends from many of the sector’s countries over time.

The outlook for the eurozone appears much more challenging, with negative demographics, ongoing austerity and, so far, little apparent interest in developing its shale reserves. We consequently expect growth to remain low and debt levels to remain high.

We expect to see a short-term bounce in Japanese activity thanks to prime minister Shinzo Abe’s Abenomics’, but long-term structural obstacles – including demographics and the lack of shale reserves – remain.

Nigel Webber is chief investment officer of HSBC Private Bank, while Esty Dwek is an investment strategist. The views expressed here are their own.

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